Lec 10 MCQs Chapters 156 - The Monetary Policy

Chapter
15
Tools for Monetary Policy
15.1 The Market for Reserve and the Federal Funds Rate
1) The Fed uses three policy tools to manipulate the money supply: ________, which affect reserves
and the monetary base; changes in ________, which affect the monetary base; and changes in
________, which affect the money multiplier.
A) open market operations; borrowed reserves; margin requirements
B) open market operations; borrowed reserves; reserve requirements
C) borrowed reserves; open market operations; margin requirements
D) borrowed reserves; open market operations; reserve requirements
Answer: B
Ques Status: Previous Edition
2) The Fed uses three policy tools to manipulate the money supply: open market operations, which
affect the ________; changes in borrowed reserves, which affect the ________; and changes in
reserve requirements, which affect the ________.
A) money multiplier; monetary base; monetary base
B) monetary base; money multiplier; monetary base
C) monetary base; monetary base; money multiplier
D) money multiplier; money multiplier; monetary base
Answer: C
3) The interest rate charged on overnight loans of reserves between banks is the
A) prime rate.
B) discount rate.
C) federal funds rate.
D) Treasury bill rate.
Answer: C
4) The primary indicator of the Fedʹs stance on monetary policy is
A) the discount rate.
B) the federal funds rate.
C) the growth rate of the monetary base.
D) the growth rate of M2.
Answer: B
5) The quantity of reserves demanded equals
A) required reserves plus borrowed reserves.
B) excess reserves plus borrowed reserves.
C) required reserves plus excess reserves.
D) total reserves minus excess reserves.
Answer: C
320 Mishkin · The Economics of Money, Banking, and Financial Markets, 9th Edition
6) Everything else held constant, when the federal funds rate is ________ the interest rate paid on
reserves, the quantity of reserves demanded rises when the federal funds rate ________.
A) above, rises
B) above, falls
C) below, rises
D) below, falls
Answer: B
Ques Status: Revised
7) The opportunity cost of holding excess reserves is the federal funds rate ________.
A) minus the discount rate
B) plus the discount rate
C) plus the interest rate paid on excess reserves
D) minus the interest rate paid on excess reserves
Answer: D
8) In the market for reserves, when the federal funds rate is above the interest rate paid on excess
reserves, the demand curve for reserves is ________.
A) vertical
B) horizontal
C) positively sloped
D) negatively sloped
Answer: D
Ques Status: New
9) When the federal funds rate equals the interest rate paid on excess reserves ________.
A) the supply curve of reserves is vertical
B) the supply curve of reserves is horizontal
C) the demand curve for reserves is vertical
D) the demand curve for reserves is horizontal
Answer: D
Ques Status: New
10) Which of the following is NOT an argument for the Federal Reserve paying interest on excess
reserve holdings?
A) Paying interest reduces the effective tax on deposits.
B) Paying interest will help in the implementation of monetary policy.
C) Paying interest will help the Federal Reserve have more control of the amount of discount
loans.
D) Paying interest increases the capacity of the Fedʹs balance sheet which will make it easier
to address financial crises.
Answer: C
Ques Status: New
Chapter 15 Tools for Monetary Policy 321
11) The quantity of reserves supplied equals
A) nonborrowed reserves minus borrowed reserves.
B) nonborrowed reserves plus borrowed reserves.
C) required reserves plus borrowed reserves.
D) total reserves minus required reserves.
Answer: B
12) In the market for reserves, when the federal funds interest rate is below the discount rate, the
supply curve of reserves is
A) vertical.
B) horizontal.
C) positively sloped.
D) negatively sloped.
Answer: A
13) When the federal funds rate equals the discount rate
A) the supply curve of reserves is vertical.
B) the supply curve of reserves is horizontal.
C) the demand curve for reserves is vertical.
D) the demand curve for reserves is horizontal.
Answer: B
14) In the market for reserves, if the federal funds rate is above the interest rate paid on excess
reserves, then an open market ________ the supply of reserves, raising the federal funds interest
rate, everything else held constant.
A) sale decreases
B) sale increases
C) purchase increases
D) purchase decreases
Answer: A
reserves, an open market purchase ________ the ________ of reserves which causes the federal
funds rate to fall, everything else held constant.
A) increases; supply
B) increases; demand
C) decreases; supply
D) decreases; demand
Answer: A
16) Suppose on any given day there is an excess demand of reserves in the federal funds market. If
the Federal Reserve wishes to keep the federal funds rate at its current level, then the
appropriate action for the Federal Reserve to take is a ________ open market ________,
everything else held constant.
A) defensive; sale
B) defensive; purchase
C) dynamic; sale
D) dynamic; purchase
Answer: B
reserves, an open market purchase ________ the supply of reserves and causes the federal funds
interest rate to ________, everything else held constant.
A) decreases; fall
B) increases; fall
C) increases; rise
D) decreases; rise
Answer: B
18) Suppose on any given day the prevailing equilibrium federal funds rate is above the Federal
Reserveʹs federal funds target rate. If the Federal Reserve wishes for the federal funds rate to be
at their target level, then the appropriate action for the Federal Reserve to take is a ________
open market ________, everything else held constant.
A) defensive; sale
C) dynamic; sale
Answer: D
reserves, an open market sale ________ the supply of reserves causing the federal funds rate to
________, everything else held constant.
A) decreases; decrease
B) increases; decrease
C) increases; increase
D) decreases; increase
Answer: D
20) Suppose on any given day there is an excess supply of reserves in the federal funds market. If
the Federal Reserve wishes to keep the federal funds rate at its current level, then the
appropriate action for the Federal Reserve to take is a ________ open market ________,
everything else held constant.
A) defensive; sale
C) dynamic; sale
Answer: A
21) Suppose on any given day the prevailing equilibrium federal funds rate is below the Federal
Reserveʹs federal funds target rate. If the Federal Reserve wishes for the federal funds rate to be
at their target level, then the appropriate action for the Federal Reserve to take is a ________
open market ________, everything else held constant.
A) defensive; sale
C) dynamic; sale
Answer: C
reserves, an open market sale ________ the ________ of reserves, causing the federal funds rate
to increase, everything else held constant.
A) increases; supply
C) decreases; supply
D) decreases; demand
Answer: C
23) In the market for reserves, a lower discount rate
A) decreases the supply of reserves.
B) increases the supply of reserves.
C) lengthens the vertical section of the supply curve of reserves.
D) shortens the vertical section of the supply curve of reserves.
Answer: D
24) In the market for reserves, a lower interest rate paid on excess reserves
A) decreases the supply of reserves.
B) increases the supply of reserves.
C) decreases the effective floor for the federal funds rate.
D) increases the effective floor for the federal funds rate.
Answer: C
Ques Status: New
25) Everything else held constant, in the market for reserves, when the federal funds rate is 3%,
lowering the discount rate from 5% to 4%
A) lowers the federal funds rate.
B) raises the federal funds rate.
C) has no effect on the federal funds rate.
D) has an indeterminate effect on the federal funds rate.
Answer: C
increasing the interest rate paid on excess reserves from 1% to 2%
B) raises the federal funds rate
Answer: C
Ques Status: New
lowering the discount rate from 5% to 4%
Answer: A
increasing the interest rate paid on excess reserves from 1% to 2%
Answer: B
Ques Status: New
raising the discount rate from 5% to 6%
Answer: C
lowering the interest rate paid on excess reserves rate from 2% to 1%
Answer: C
Ques Status: New
31) Everything else held constant, in the market for reserves, when the federal funds rate equals the
discount rate, lowering the discount rate
A) increases the federal funds rate.
B) lowers the federal funds rate.
D) has an indeterminate effect of the federal funds rate.
Answer: B
32) Everything else held constant, in the market for reserves, when the federal funds rate equals the
interest rate paid on excess reserves, raising the interest rate paid on excess reserves
Answer: A
Ques Status: New
33) Everything else held constant, in the market for reserves, when the demand for federal funds
intersects the reserve supply curve along the horizontal section, increasing the discount rate
Answer: A
34) Everything else held constant, in the market for reserves, when the supply for federal funds
intersects the reserve demand curve along the horizontal section, lowering the interest rate paid
on excess reserves
Answer: A
Ques Status: New
35) Everything else held constant, in the market for reserves, when the demand for federal funds
intersects the reserve supply curve on the vertical section, increasing the discount rate
Answer: C
36) Everything else held constant, in the market for reserves, when the supply for federal funds
intersects the reserve demand curve on the downward sloping section, decreasing the interest
rate paid on excess reserves
Answer: C
Ques Status: New
37) Everything else held constant, in the market for reserves, increases in the discount rate affect the
federal funds rate
A) when the funds rate is below the discount rate.
B) when the funds rate equals the discount rate.
C) when the demand for federal funds intersects the vertical section of the reserve supply
curve.
D) when the demand for federal funds equals zero.
Answer: B
38) Everything else held constant, in the market for reserves, decreases in the interest rate paid on
excess reserves affect the federal funds rate
A) when the funds rate is below the interest rate paid on excess reserves.
B) when the funds rate equals the interest rate paid on excess reserves.
C) when the funds rate is below the discount rate.
D) when the funds rate equals the discount rate.
Answer: B
Ques Status: New
39) The Federal Reserve usually keeps the discount rate
A) above the target federal funds rate.
B) equal to the target federal funds rate.
C) below the target federal funds rate.
D) equal to zero.
Answer: A
40) Everything else held constant, the vertical section of the supply curve of reserves is shortened
when the
A) discount rate increases.
B) discount rate decreases.
C) federal funds rate rises.
D) federal funds rate falls.
Answer: B
41) Everything else held constant, the vertical section of the supply curve of reserves is lengthened
when the
A) discount rate increases.
B) discount rate decreases.
C) federal funds rate rises.
D) federal funds rate falls.
Answer: A
42) In the market for reserves, if the federal funds rate is between the discount rate and the interest
rate paid on excess reserves, an increase in the reserve requirement ________ the demand for
reserves, ________ the federal funds rate, everything else held constant.
A) decreases; lowering
B) increases; lowering
C) increases; raising
D) decreases; raising
Answer: C
rate paid on excess reserves, a ________ in the reserve requirement ________ the demand for
reserves, raising the federal funds interest rate, everything else held constant.
A) rise; decreases
B) rise; increases
C) decline; increases
D) decline; decreases
Answer: B
rate paid on excess reserves, a ________ in the reserve requirement increases the demand for
reserves, ________ the federal funds interest rate, everything else held constant.
A) rise; lowering
B) decline; raising
C) decline; lowering
D) rise; raising
Answer: D
rate paid on excess reserves, an increase in the reserve requirement ________ the demand of
reserves and causes the federal funds interest rate to ________, everything else held constant.
A) decreases; fall
B) increases; fall
C) increases; rise
D) decreases; rise
Answer: C
rate paid on excess reserves, an increase in the reserve requirement ________ the ________ for
reserves and causes the federal funds interest rate to rise, everything else held constant.
A) decreases; demand
C) increases; supply
D) decreases; supply
Answer: B
rate paid on excess reserves, a ________ in the reserve requirement ________ the demand for
reserves, lowering the federal funds interest rate, everything else held constant.
A) rise; decreases
B) rise; increases
C) decline; increases
D) decline; decreases
Answer: D
rate paid on excess reserves, a ________ in the reserve requirement decreases the demand for
reserves, ________ the federal funds interest rate, everything else held constant.
A) rise; lowering
B) decline; raising
C) decline; lowering
D) rise; raising
Answer: C
rate paid on excess reserves, a decline in the reserve requirement ________ the ________ curve of
reserves and causes the federal funds interest rate to fall, everything else held constant.
A) decreases; demand
C) increases; supply
D) decreases; supply
Answer: A
rate paid on excess reserves, a decline in the reserve requirement ________ the demand of
reserves, ________ the federal funds rate, everything else held constant.
A) decreases; lowering
B) increases; lowering
C) increases; raising
D) decreases; raising
Answer: A
51) Suppose, at a given federal funds rate, there is an excess demand for reserves in the federal
funds market. If the Fed wants the federal funds rate to stay at that level, then it should
undertake an open market ________ of bonds, everything else held constant. If the Fed does
nothing, however, the federal funds rate will ________.
A) sale; increase
B) purchase; increase
C) sale; decrease
D) purchase; decrease
Answer: B
52) Suppose, at a given federal funds rate, there is an excess supply of reserves in the federal funds
market. If the Fed wants the federal funds rate to stay at that level, then it should undertake an
open market ________ of bonds, everything else held constant. If the Fed does nothing,
however, the federal funds rate will ________.
A) sale; increase
B) purchase; increase
C) sale; decrease
D) purchase; decrease
Answer: C
53) Explain the Fedʹs three tools of monetary policy and how each is used to change the money
supply. Does each tool affect the monetary base or the money multiplier?
Answer: The three tools are open market operations, the purchase and sale of government
securities; discount policy, controlling the price and quantity of discount loans to banks;
and reserve requirements, setting the percentage of deposits that banks must hold in
reserve. Open market operations and the discount rate affect the monetary base, and
reserve requirements affect the money multiplier.
54) State whether the following statement is true or false AND explain why: ʺA decrease in the

discount rate will always cause a decrease in the federal reserve funds rate.ʺ
Answer: False. Since the discount rate is set above the federal funds rate, a decrease in the discount
rate will only cause a decrease in the federal funds rate if the discount rate is decreased
below the original federal funds rate level. If the decrease in the discount rate is such that
the new rate is still above the federal funds rate, then the federal funds rate does not
change, everything else held constant.
55) State whether the following statement is true or false AND explain why: ʺAn increase in the

interest rate paid on excess reserves will always cause an increase in the federal reserve funds
rate.ʺ
Answer: False. If the interest rate paid on excess reserves is set below the federal funds rate, an
increase in the interest rate paid on excess reserves will only cause an increase in the
federal funds rate if the interest rate paid on excess reserves is increased above the
original federal funds rate level. If the increase in the interest rate paid on excess reserves
is such that the new rate is still below the federal funds rate, then the federal funds rate
does not change, everything else held constant.
Ques Status: New
15.2 Open Market Operations
1) ________ are the most important monetary policy tool because they are the primary determinant
of changes in the ________, the main source of fluctuations in the money supply.
A) Open market operations; monetary base
B) Open market operations; money multiplier
C) Changes in reserve requirements; monetary base
D) Changes in reserve requirements; money multiplier
Answer: A
2) Open market purchases raise the ________ thereby raising the ________.
A) money multiplier; money supply
B) money multiplier; monetary base
C) monetary base; money supply
D) monetary base; money multiplier
Answer: C
3) Open market purchases ________ reserves and the monetary base thereby ________ the money
supply.
A) raise; lowering
B) raise; raising
C) lower; lowering
D) lower; raising
Answer: B
4) Open market sales shrink ________ thereby lowering ________.
A) the money multiplier; the money supply
B) the money multiplier; reserves and the monetary base
C) reserves and the monetary base; the money supply
D) the money base; the money multiplier
Answer: C
5) Open market sales ________ reserves and the monetary base thereby ________ the money
supply.
A) raise; lowering
B) raise; raising
C) lower; lowering
D) lower; raising
Answer: C
6) The two types of open market operations are
A) offensive and defensive.
B) dynamic and reactionary.
C) active and passive.
D) dynamic and defensive.
Answer: D
7) There are two types of open market operations: ________ open market operations are intended
to change the level of reserves and the monetary base, and ________ open market operations are
intended to offset movements in other factors that affect the monetary base.
A) defensive; dynamic
B) defensive; static
C) dynamic; defensive
D) dynamic; static
Answer: C
8) Open market operations intended to offset movements in noncontrollable factors (such as float)
that affect reserves and the monetary base are called
A) defensive open market operations.
B) dynamic open market operations.
C) offensive open market operations.
D) reactionary open market operations.
Answer: A
9) When the Federal Reserve engages in a repurchase agreement to offset a withdrawal of
Treasury funds from the Federal Reserve, the open market operation is said to be
A) defensive.
B) offensive.
C) dynamic.
D) reactionary.
Answer: A
10) The Federal Open Market Committee makes the Fedʹs decisions on the purchase or sale of
government securities, but these purchases or sales are executed by the Federal Reserve Bank of
A) Chicago.
B) Boston.
C) New York.
D) San Francisco.
Answer: C
11) The actual execution of open market operations is done at
A) the Board of Governors in Washington, D.C.
B) the Federal Reserve Bank of New York.
C) the Federal Reserve Bank of Philadelphia.
D) the Federal Reserve Bank of Boston.
Answer: B
12) If float is predicted to decrease because of unseasonably good weather, the manager of the
trading desk at the Federal Reserve Bank of New York will likely conduct a ________ open
market ________ of securities.
A) defensive; sale
C) dynamic; sale
Answer: B
13) When bad storms slow the check-clearing process, float tends to ________ causing the Fed to
initiate defensive open market ________.
A) decrease; sales
B) decrease; purchases
C) increase; sales
D) increase; purchases
Answer: C
14) When good weather speeds the check-clearing process, float tends to ________ causing the Fed
to initiate defensive open market ________.
A) decrease; sales
B) decrease; purchases
C) increase; sales
D) increase; purchases
Answer: B
15) When bad storms slow the check-clearing process, float tends to ________ causing the Fed to
initiate ________ open market ________.
A) decrease; defensive; sales
B) decrease; dynamic; purchases
C) increase; defensive; sales
D) increase; dynamic; purchases
Answer: C
16) When good weather speeds the check-clearing process, float tends to ________ causing the Fed
to initiate ________ open market ________.
A) decrease; defensive; sales
B) decrease; dynamic; sales
C) decrease; defensive; purchases
D) increase; dynamic; purchases
Answer: C
17) If float is predicted to increase because of bad weather, the manager of the trading desk at the
New York Fed bank will likely conduct ________ open market operations to ________ reserves.
A) defensive; inject
B) defensive; drain
C) dynamic; inject
D) dynamic; drain
Answer: B
18) If float is predicted to decrease because of good weather, the manager of the trading desk at the
B) defensive; drain
C) dynamic; inject
D) dynamic; drain
Answer: A
19) If Treasury deposits at the Fed are predicted to increase, the manager of the trading desk at the
B) defensive; drain
C) dynamic; inject
D) dynamic; drain
Answer: A
20) If Treasury deposits at the Fed are predicted to ________, the manager of the trading desk at the
A) increase; defensive; inject
B) decrease; defensive; drain
C) increase; dynamic; inject
D) decrease; dynamic; drain
Answer: A
21) If Treasury deposits at the Fed are predicted to fall, the manager of the trading desk at the New
York Fed bank will likely conduct ________ open market operations to ________ reserves.
B) defensive; drain
C) dynamic; inject
D) dynamic; drain
Answer: B
22) If Treasury deposits at the Fed are predicted to ________, the manager of the trading desk at the
A) rise; defensive; drain
B) fall; defensive; drain
C) rise; dynamic; inject
D) fall; dynamic; drain
Answer: B
23) If the Fed expects currency holdings to rise, it conducts open market ________ to offset the
expected ________ in reserves.
A) purchases; increase
B) purchases; decrease
C) sales; increase
D) sales; decrease
Answer: B
24) If the Fed expects currency holdings to fall, it conducts open market ________ to offset the
expected ________ in reserves.
A) purchases; increase
B) purchases; decrease
C) sales; increase
D) sales; decrease
Answer: C
25) If the banking system has a large amount of reserves, many banks will have excess reserves to
lend and the federal funds rate will probably ________; if the level of reserves is low, few banks
will have excess reserves to lend and the federal funds rate will probably ________.
A) fall; fall
B) fall; rise
C) rise; fall
D) rise; rise
Answer: B
26) The Federal Reserve will engage in a repurchase agreement when it wants to ________ reserves
________ in the banking system.
A) increase; permanently
B) increase; temporarily
C) decrease; temporarily
D) decrease; permanently
Answer: B
27) If the Fed wants to temporarily inject reserves into the banking system, it will engage in
A) a repurchase agreement.
B) a matched sale-purchase transaction.
C) a reverse repurchase agreement.
D) an open market sale.
Answer: A
28) The Fed can offset the effects of an increase in float by engaging in
A) a repurchase agreement.
B) a matched sale-purchase transaction.
C) an interest rate swap.
D) an open market purchase.
Answer: B
29) The Federal Reserve will engage in a matched sale-purchase transaction when it wants to
________ reserves ________ in the banking system.
A) increase; permanently
B) increase; temporarily
C) decrease; temporarily
D) decrease; permanently
Answer: C
30) Explain dynamic and defensive open market operations. What is the purpose of each type?
Describe two situations when defensive open market operations are used. How are defensive
open market operations typically conducted?
Answer: Dynamic OMOs are used to permanently change the monetary base and money supply.
Defensive operations are used to offset temporary changes in the monetary base and/or
money supply. Defensive operations are used to offset float, shifts in Treasury balances
into or out of the Fed, and temporary changes in currency. Defensive purchases are
typically conducted by using repurchase agreements, while reverse repos or matched
sale-purchase transactions are used to conduct defensive open market sales.
15.3 Discount Policy
1) Discount policy affects the money supply by affecting the volume of ________ and the ________.
A) excess reserves; monetary base
B) borrowed reserves; monetary base
C) excess reserves; money multiplier
D) borrowed reserves; money multiplier
Answer: B
2) The discount rate is
A) the interest rate the Fed charges on loans to banks.
B) the price the Fed pays for government securities.
C) the interest rate that banks charge their most preferred customers.
D) the price banks pay the Fed for government securities.
Answer: A
3) The most common type of discount lending that the Fed extends to banks is called
A) seasonal credit.
B) secondary credit.
C) primary credit.
D) installment credit.
Answer: C
4) The most common type of discount lending, ________ credit loans, are intended to help healthy
banks with short-term liquidity problems that often result from temporary deposit outflows.
A) secondary
B) primary
C) temporary
D) seasonal
Answer: B
5) When the Fed acts as a lender of last resort, the type of lending it provides is
A) primary credit.
B) seasonal credit.
C) secondary credit.
D) installment credit.
Answer: C
6) The Fedʹs discount lending is of three types: ________ is the most common category; ________ is
given to a limited number of banks in vacation and agricultural areas; ________ is given to
banks that have experienced severe liquidity problems.
A) seasonal credit; secondary credit; primary credit
B) secondary credit; seasonal credit; primary credit
C) primary credit; seasonal credit; secondary credit
D) seasonal credit; primary credit; secondary credit
Answer: C
7) The discount rate is ________ kept ________ the federal funds rate.

A) always; below
B) typically; below
C) typically; equal to
D) typically; above
Answer: D
8) The discount rate refers to the interest rate on
A) primary credit.
B) secondary credit.
C) seasonal credit.
D) federal funds.
Answer: A
9) The interest rate on secondary credit is set ________ basis points ________ the primary credit
rate.
A) 100; above
B) 100; below
C) 50; above
D) 50; below
Answer: C
10) The interest rate for primary credit is usually set ________ basis points ________ the federal

funds rate. In March 2008, this gap was changed to ________ basis points.
A) 50; below; 100
B) 100; above; 25
C) 100; below; 50
D) 50; above; 25
Answer: B
11) The interest rate on seasonal credit equals
A) the federal funds rate.
B) the primary credit rate.
C) the secondary credit rate.
D) an average of the federal funds rate and rates on certificates of deposits.
Answer: D
12) The Fed is considering eliminating
A) primary credit lending.
B) secondary credit lending.
C) seasonal credit lending.
D) its lender of last resort function.
Answer: C
13) At its inception, the Federal Reserve was intended to be
A) the Treasuryʹs banker.
B) the issuer of government debt.
C) a lender-of-last-resort.
D) a regulator of bank holding companies.
Answer: C
14) Much of the credit for prevention of a financial market meltdown after ʺBlack Mondayʺ (October
19, 1987) must be given to the Federal Reserve System and its chairman
A) Paul Volker.
B) Alan Blinder.
C) Arthur Burns.
D) Alan Greenspan.
Answer: D
15) A financial panic was averted in October 1987 following ʺBlack Mondayʺ when the Fed
announced that
A) it was lowering the discount rate.
B) it would provide discount loans to any bank that would make loans to the security
industry.
C) it stood ready to purchase common stocks to prevent a further slide in stock prices.
D) it was raising the discount rate.
Answer: B
16) The facility that was created in December of 2007 that banks can use to borrow from the Fed that
has less of a stigma for banks compared to borrowing from the discount window is the
________.
A) Term Securities Lending Facility
B) Term Auction Facility
C) Primary Dealer Credit Facility
D) Commerical Paper Funding Facility
Answer: B
Ques Status: New
17) Which of the following special lending facilities set up by the Federal Reserve is reserve neutral?
A) Term Auction Facility
B) Primary Dealer Credit Facility
C) Term Securities Lending Facility
D) Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility
Answer: C
Ques Status: New
18) The Fedʹs lender-of-last-resort function
A) has proven to be ineffective.
B) cannot prevent runs by large depositors.
C) is no longer necessary due to FDIC insurance.
D) creates a moral hazard problem.
Answer: D
19) The most important advantage of discount policy is that the Fed can use it to
A) precisely control the monetary base.
B) perform its role as lender of last resort.
C) control the money supply.
D) punish banks that have deficient reserves.
Answer: B
15.4 Reserve Requirements
1) An increase in ________ reduces the money supply since it causes the ________ to fall.
A) reserve requirements; monetary base
B) reserve requirements; money multiplier
C) margin requirements; monetary base
D) margin requirements; money multiplier
Answer: B
2) A decrease in ________ increases the money supply since it causes the ________ to rise.
A) reserve requirements; monetary base
B) reserve requirements; money multiplier
C) margin requirements; monetary base
D) margin requirements; money multiplier
Answer: B
3) The Federal Reserve has had the authority to vary reserve requirements since the
A) 1920s.
B) 1930s.
C) 1940s.
D) 1950s.
Answer: B
4) Since 1980, ________ are subject to reserve requirements.
A) only commercial banks
B) only the member institutions of the Federal Reserve
C) only nationally chartered depository institutions
D) all depository institutions
Answer: D
5) Funds held in ________ are subject to reserve requirements.
A) all checkable deposits
B) all checkable and time deposits
C) all checkable, time, and money market fund deposits
D) all time deposits
Answer: A
6) The policy tool of changing reserve requirements is
A) the most widely used.
B) the preferred tool from the bankʹs perspective.
C) no longer used.
D) still used, even with its disadvantages.
Answer: C
15.5 Monetary Policy Tools of the European Central Bank
1) The European System of Central Banks signals the stance of its monetary policy by setting a
target for the
A) federal funds rate.
B) overnight cash rate.
C) lombard rate.
D) reserve rate.
Answer: B
2) When the European System of Central Banks uses main refinancing operations, it is similar to
the Federal Reserve using
A) dynamic open market operations.
B) defensive open market operations.
C) discount policy.
D) reserve requirements.
Answer: B
3) When the European System of Central Banks uses long -term refinancing operations, it is similar
to the Federal Reserve using
A) dynamic open market operations.
B) defensive open market operations.
C) discount policy.
D) reserve requirements.
Answer: A
4) The equivalent to the Federal Reserveʹs discount rate in the European System of Central Banks is
the
A) federal funds rate.
B) marginal lending rate.
C) deposit facility rate.
D) lombard rate.
Answer: B
5) The Federal Reserve ________ pay interest on reserves held on deposit. The European System of
Central Banks ________ pay interest on reserves held on deposit.
A) does; does
B) does; does not
C) does not; does
D) does not; does not
Answer: C
6) Since the European Central Bank ________ interest on reserves, banks have a ________ cost of
complying with reserve requirements when compared to banks complying with the reserve
requirements of the Federal Reserve.
A) pays; lower
B) pays; higher
C) does not pay; lower
D) does not pay; higher
Answer: A
Chapter 16
The Conduct of Monetary Policy: Strategy and Tactics
16.1 Monetary Targeting
1) Under monetary targeting, a central bank announces an annual growth rate target for ________.
A) a monetary aggregate
B) a reserve aggregate
C) the monetary base
D) GDP
Answer: A
2) During the years 1979 to 1982, the Federal Reserveʹs announced policy was monetary targeting.
During this time period the Federal Reserve
A) hit all of their monetary targets.
B) did not hit any of their monetary targets because it is believed that controlling the money
supply was not the intent of the Federal Reserve.
C) did not hit any of their monetary targets because they were unrealistic.
D) hit about half of their monetary targets.
Answer: B
3) Compared to the United States, Japanʹs experience with monetary targeting performed
A) better with regard to the inflation rate and output fluctuations.
B) worse with regard to the inflation rate and output fluctuations.
C) better with regard to the inflation rate, but worse with regard to output fluctuations.
D) worse with regard to the inflation rate, but better with regard to output fluctuations.
Answer: A
4) One of the factors that contributed to the success German policymakers had using a monetary
targeting type policy was that
A) they used a rigid target for the money growth rate.
B) they implemented policy so their inflation rate goal was met in the short run.
C) the money target was flexible to allow the Bundesbank to concentrate on other goals as
needed.
D) they rarely communicated the intentions of policy to the public in order to keep the public
from panicking.
Answer: C
5) Which of the following is the best description of the monetary policy strategy followed by the
European Central Bank (ECB)?
A) The ECB follows monetary targeting.
B) The ECB follows inflation targeting.
C) The ECB has a hybrid strategy with elements of both monetary targeting and inflation
targeting.
D) The ECB has a Fed-like ʺjust do itʺ approach.
Answer: C
Ques Status: New
6) Which of the following is an advantage to money targeting?
A) There is an immediate signal on the achievement of the target.
B) It does not rely on a stable money-inflation relationship.
C) It implies lack of transparency.
D) It implies smaller output fluctuations.
Answer: A
7) Which of the following is a disadvantage to monetary targeting?
A) It relies on a stable money-inflation relationship.
B) There is a delayed signal about the achievement of a target.
C) It implies larger output fluctuations.
D) It implies a lack of transparency.
Answer: A
8) If the relationship between the monetary aggregate and the goal variable is weak, then
A) monetary aggregate targeting is superior to exchange -rate targeting.
B) monetary aggregate targeting is superior to inflation targeting.
C) inflation targeting is superior to exchange-rate targeting.
D) monetary aggregate targeting will not work.
Answer: D
9) The monetary policy strategy that provides an immediate signal on target achievement is
A) exchange-rate targeting.
B) monetary targeting.
C) inflation targeting.
D) the implicit nominal anchor.
Answer: B
10) The monetary policy strategy that relies on a stable money-income relationship is
Answer: B
Chapter 16 The Conduct of Monetary Policy: Strategy and Tactics 345
16.2 Inflation Targeting
1) The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom is
A) monetary targeting.
B) inflation targeting.
C) targeting with an implicit nominal anchor.
D) interest-rate targeting.
Answer: B
2) Which of the following is NOT an element of inflation targeting?
A) A public announcement of medium-term numerical targets for inflation
B) An institutional commitment to price stability as the primary long-run goal
C) An information-inclusive approach in which only monetary aggregates are used in
making decisions about monetary policy
D) Increased accountability of the central bank for attaining its inflation objectives
Answer: C
3) The first country to adopt inflation targeting was
A) the United Kingdom.
B) Canada.
C) New Zealand.
D) Australia.
Answer: C
4) In both New Zealand and Canada, what has happened to the unemployment rate since the
countries adopted inflation targeting?
A) The unemployment rate increased sharply.
B) The unemployment rate remained constant.
C) The unemployment rate has declined substantially after a sharp increase.
D) The unemployment rate declined sharply immediately after the inflation targets were
adopted.
Answer: C
5) Which of the following is NOT an advantage of inflation targeting?
A) There is simplicity and clarity of the target.
B) Inflation targeting does not rely on a stable money -inflation relationship.
C) There is an immediate signal on the achievement of the target.
D) Inflation targeting reduces the effects of inflation shocks.
Answer: C
6) Which of the following is NOT a disadvantage to inflation targeting?
A) There is a delayed signal about achievement of the target.
B) Inflation targets could impose a rigid rule on policymakers.
C) There is potential for larger output fluctuations.
D) There is a lack of transparency.
Answer: D
7) The decision by inflation targeters to choose inflation targets ________ zero reflects the concern
of monetary policymakers that particularly ________ inflation can have substantial negative
effects on real economic activity.
A) below; high
B) below; low
C) above; high
D) above; low
Answer: D
8) Inflation targets can increase the central bankʹs flexibility in responding to declines in aggregate
spending. Declines in aggregate ________ that cause the inflation rate to fall below the floor of
the target range will automatically stimulate the central bank to ________ monetary policy
without fearing that this action will trigger a rise in inflation expectations.
A) demand: tighten
B) demand; loosen
C) supply; tighten
D) supply; loosen
Answer: B
9) Explain what inflation targeting is. What are the advantages and disadvantages of this type of
monetary policy strategy?
Answer: There are five main elements to inflation targeting: 1. a public announcement of a
medium-term target for the inflation rate; 2. a commitment to price stability as the
primary long-term goal of policy; 3. many variables are used in making decisions about
policy moves; 4. increased transparency about policy strategy with the public; 5. the
central bank has increased accountability for attaining policy goals.
The advantages of inflation targeting include: 1. the simplicity and clarity of a numerical
target for the inflation rate; 2. does not rely on a stable money-inflation relationship; 3.
there is increased accountability of the central bank; 4. reduces the effects of inflationary
shocks.
The disadvantages of inflation targeting include: 1. there is a delayed signal about the
achievement of the target; 2. it could lead to a rigid rule where the only focus is the
inflation rate (has not happened in practice); 3. if sole focus is the inflation rate, larger
output fluctuations can occur (has not happened in practice).
16.3 Monetary Policy with an Implicit Nominal Anchor
1) The type of monetary policy regime that the Federal Reserve has been following in recent years
can best be described as
A) monetary targeting.
B) inflation targeting.
C) policy with an implicit nominal anchor.
D) exchange-rate targeting.
Answer: C
2) Estimates suggest that, in the United States economy, it takes just over ________ for monetary
policy to affect output and just over ________ for monetary policy to affect the inflation rate.
A) 1 year; 2 years
B) 2 years; 1 year
C) 1 year; 6 months
D) 6 months; 1 year
Answer: A
3) Which of the following is an advantage of the Fedʹs ʺjust do itʺ approach to monetary policy?
A) It does not rely on the money-inflation relationship.
B) It is simplistic and has clarity.
C) There is increased accountability of central bankers.
D) There is an immediate signal if the target has been achieved.
Answer: A
4) Which of the following is NOT a disadvantage of of the Fedʹs ʺjust do itʺ approach to monetary
policy?
A) There is low transparency of policy.
B) There is low accountability for central bankers.
C) This type of policy relies on the policy-makers in charge.
D) It relies on a stable money-inflation relationship.
Answer: D
5) When compared to the Fedʹs ________ anchor approach, ________ targeting can make the
institutional framework for the conduct of monetary policy more consistent with democratic
principles.
A) nominal; inflation
B) implicit; monetary
C) nominal; monetary
D) implicit; inflation
Answer: D
6) The monetary policy strategy that suffers a lack of transparency is
Answer: D
7) The monetary policy strategy that provides the least accountability is
Answer: D
8) Explain the Federal Reserveʹs ʺjust do itʺ approach to monetary policy. What are the advantages
and disadvantages to this type of strategy?
Answer: The Federal Reserve doesnʹt use an explicit nominal anchor such as a monetary aggregate
or the inflation rate. Its strategy revolves around using an implicit nominal anchor in the
form of an overriding concern to control inflation in the long run. This involves
forward-looking behavior and ʺpre-emptive strikesʺ by policy actions to prevent
inflation. This forward-looking behavior is necessary because of the long time lags
between monetary policy action and its impact on inflation.
The advantages of this policy strategy include: 1. it doesnʹt rely on a stable
money-inflation relationship; 2. the demonstrated success it has had in the United States.
The disadvantages of this policy strategy include: 1. there is a lack of transparency; 2. its
success depends on the individuals in charge of policy; 3. there is low accountability of
the central bank.
16.4 Tactics: Choosing the Policy Instrument
1) Which of the following is not an operating instrument?
A) Nonborrowed reserves
B) Monetary base
C) Federal funds interest rate
D) Discount rate
Answer: D
2) Which of the following is a potential operating instrument for the central bank?
A) The monetary base
B) The M1 money supply
C) Nominal GDP
D) The discount rate
Answer: A
3) Due to the lack of timely data for the price level and economic growth, the Fedʹs strategy
A) targets the exchange rate, since the Fed can control this variable.
B) targets the price of gold, since it is closely related to economic activity.
C) uses an intermediate target, such as an interest rate.
D) stabilizes the consumer price index, since the Fed can control the CPI.
Answer: C
4) If the central bank targets a monetary aggregate, it is likely to lose control over the interest rate
because
A) of fluctuations in the demand for reserves.
B) of fluctuations in the consumption function.
C) bond values will tend to remain stable.
D) of fluctuations in the business cycle.
Answer: A
5) If the Fed pursues a strategy of targeting an interest rate when fluctuations in money demand
are prevalent,
A) fluctuations of nonborrowed reserves will be small.
B) fluctuations of nonborrowed reserves will be large.
C) the Fed will probably quickly abandon this policy, as it did in the 1960s.
D) the Fed will probably quickly abandon this policy, as it did in the 1950s.
Answer: B
6) Fluctuations in the demand for reserves cause the Fed to lose control over a monetary aggregate
if the Fed targets
A) a monetary aggregate.
B) the monetary base.
C) an interest rate.
D) nominal GDP.
Answer: C
7) Interest rates are difficult to measure because
A) data on them are not available in a timely manner.
B) real interest rates depend on the hard-to-determine expected inflation rate.
C) they fluctuate too often to be accurate.
D) they cannot be controlled by the Fed.
Answer: B
8) Which of the following criteria need not be satisfied for choosing an intermediate target?
A) The variable must be measurable.
B) The variable must be controllable.
C) The variable must be predictable.
D) The variable must be transportable.
Answer: D
9) Which of the following is not a requirement in selecting an intermediate target?
A) Measurability
B) Controllability
C) Flexibility
D) Predictability
Answer: C
10) When it comes to choosing an policy instrument, both the ________ rate and ________
aggregates are measured accurately and are available daily with almost no delay.
A) three-month T-bill; monetary
B) three-month T-bill; reserve
C) federal funds; monetary
D) federal funds; reserve
Answer: D
11) If the desired intermediate target is an interest rate, then the preferred policy instrument will be
a(n) ________ variable like the ________.
A) interest rate; three-month T-bill rate
B) interest rate; federal funds rate
C) monetary aggregate; monetary base
D) monetary aggregate; nonborrowed base
Answer: B
12) If the desired intermediate target is a monetary aggregate, then the preferred policy instrument
will be a(n) ________ variable like the ________.
A) interest rate; three-month T-bill rate
B) interest rate; federal funds rate
C) reserve aggregate; monetary base
D) reserve aggregate; narrow money supply M1
Answer: C
13) If the desired intermediate target is a monetary aggregate, which of the following would be the
most preferred policy instrument?
A) The federal funds rate
B) The 90-day T-bill rate
C) The 180-day T-bill rate
D) The monetary base
Answer: D
14) If the desired intermediate target is an interest rate, the preferred policy instrument would be
A) the federal funds rate.
B) the monetary base.
C) nonborrowed reserves.
D) borrowed reserves.
E) the discount rate.
Answer: A
15) Explain and demonstrate graphically how targeting nonborrowed reserves can result in federal
funds rate instability.
Answer: See figure below.
When nonborrowed reserves are held constant, increases in the demand for reserves
result in the federal funds rate increasing and decreases in the demand for nonborrowed
reserves result in the federal funds rate declining. Since fluctuations in demand do not
cause monetary policy actions, the result is the federal funds rate will fluctuate (assuming
the equilibrium federal funds rate is below the discount rate).
16) Explain and demonstrate graphically how targeting the federal funds rate can result in
fluctuations in nonborrowed reserves.
Answer: See figure below.
With a federal funds rate target, fluctuations in demand for reserves require similar
changes in the nonborrowed reserves to keep the federal funds rate constant.
16.5 Tactics: The Taylor Rule
1) According to the Taylor rule, the Fed should raise the federal funds interest rate when inflation
________ the Fedʹs inflation target or when real GDP ________ the Fedʹs output target.
A) rises above; drops below
B) drops below; drops below
C) rises above; rises above
D) drops below; rises above
Answer: C
2) Using Taylorʹs rule, when the equilibrium real federal funds rate is 3 percent, the positive
output gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2
percent, the nominal federal funds rate target should be
A) 5 percent.
B) 5.5 percent.
C) 6 percent.
D) 6.5 percent.
Answer: D
3) Using Taylorʹs rule, when the equilibrium real federal funds rate is 2 percent, there is no output
gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal federal
funds rate should be
A) 0 percent.
B) 1 percent.
C) 2 percent.
D) 3 percent.
Answer: B
4) According to the Taylor Principle, when the inflation rate rises, the nominal interest rate should
be ________ by ________ than the inflation rate increase.
A) increased; more
B) increased; less
C) decreased; more
D) decreased; less
Answer: A
Ques Status: New
5) If the Taylor Principle is not followed and nominal interest rates are increased by less than the
increase in the inflation rate, then real interest rates will ________ and monetary policy will be
too ________.
A) rise; tight
B) rise; loose
C) fall; tight
D) fall; loose
Answer: D
Ques Status: New
6) The rate of inflation tends to remain constant when
A) the unemployment rate is above the NAIRU.
B) the unemployment rate equals the NAIRU.
C) the unemployment rate is below the NAIRU.
D) the unemployment rate increases faster than the NAIRU increases.
Answer: B
7) The rate of inflation increases when
A) the unemployment rate equals the NAIRU.
B) the unemployment rate exceeds the NAIRU.
C) the unemployment rate is less than the NAIRU.
D) the unemployment rate increases faster than the NAIRU increases.
Answer: C
8) Explain the Taylor rule, including the formula for setting the federal funds rate target, and the
components of the formula. If the Fed were to use this rule, how many goals would it use to set
monetary policy?
Answer: The Taylor rule specifies that the target federal fund rates should be set to equal the
equilibrium real federal funds rate, plus the rate of inflation (for the Fisher effect), plus
one-half times the output gap, plus one-half times the inflation gap. The formula is
1
Federal funds rate target = equilibrium real federal funds rate + inflation rate + (output
2
1
gap) + (inflation gap)
2
The output gap is the percentage deviation of real GDP from potential full-employment
real GDP. The inflation gap is the difference between actual inflation and the central
bankʹs target rate of inflation. The equilibrium real federal funds rate is the real rate
consistent with full employment in the long run. The inflation rate is the actual rate of
inflation. The Taylor rule sets the federal funds rate recognizing the goals of low inflation
and full employment (or equilibrium long-run economic growth).
16.6 Central Banksʹ Response to Asset-Price Bubbles: Lessons From The Subprime Crisis
1) When asset prices increase above their fundamental values it is called an ________.
A) asset-price bubble
B) irrational bubble
C) asset-price spike
D) irrational spike
Answer: A
Ques Status: New
2) Suppose interest rates are kept very low for a long time such that there is a spike in the amount
of lending. Everything else held constant, this could cause ________ bubble.
A) an irrational exuberance
B) a credit-driven
C) a stock
D) a debt-driven
Answer: B
Ques Status: New
3) A credit-driven bubble arises when ________ in lending causes ________ in asset prices which
can cause ________ in lending.
A) a decrease; a decrease; an increase
B) a decrease; an increase; an increase
C) an increase; an increase; a further increase
D) a decrease; a decrease; a further decrease
Answer: C
Ques Status: New
4) ________ bubble is driven entirely by unrealistic optimistic expectations.
A) An irrational exuberance
B) A credit-driven
C) A stock
D) A debt-driven
Answer: A
Ques Status: New
5) Everything else held constant, a credit-drive bubble is generally considered to have the
potential to cause ________ damage to an economy compared to an irrational exuberance
bubble.
A) less
B) about the same amount of
C) more
D) either more, less, or the same amount of
Answer: C
Ques Status: New
6) A central bank has ________ chance to identify a credit -driven bubble compared to an irrational
exuberance bubble.
A) a greater
B) less of a
C) about the same level of a
D) a greater, less or about the same level of a
Answer: A
Ques Status: New
7) Which of the following is NOT an argument against using monetary policy to prick asset-price
bubbles?
A) The effect of increasing interest rates on asset prices is uncertain.
B) A bubble may only exist in some asset-prices and monetary policy will affect all asset
prices.
C) Using monetary policy to prick an asset-price bubble may have adverse effect on the
aggregate economy.
D) Even though credit-drive bubbles are easier to identify, they are still relatively hard to
identify.
Answer: D
Ques Status: New
16.7 Fed Policy Procedures: Historical Perspective
1) In its earliest years, the Federal Reserveʹs guiding principle for the conduct of monetary policy
was known as the
A) real bills doctrine.
B) liberal liquidity doctrine.
C) free reserves doctrine.
D) quantity theory of money.
Answer: A
2) The guiding principle for the conduct of monetary policy that held that as long as loans were
being made for ʺproductiveʺ purposes, then providing reserves to the banking system to make
these loans would not be inflationary became known as the
A) free reserves doctrine.
B) Benjamin Strong doctrine.
C) efficient liquidity doctrine.
D) real bills doctrine.
Answer: D
3) The real bills doctrine was the guiding principle for the conduct of monetary policy during the
A) 1910s.
B) 1940s.
C) 1950s.
D) 1960s.
Answer: A
4) The Fed accidentally discovered open market operations in the early
A) 1920s.
B) 1910s.
C) 1900s.
D) 1890s.
Answer: A
5) The Fed accidentally discovered open market operations when
A) it came to the rescue of failing banks in the early 1930s, and found that its purchases of
bank loans injected reserves into the banking system.
B) it purchased securities for income following the 1920-1921 recession.
C) it attempted to slow inflation in 1919 by selling securities and found that its sales drained
reserves from the banking system.
D) it reinterpreted a key provision of the Federal Reserve Act.
Answer: B
6) The Fedʹs mistakes of the early 1930s were compounded by its decision to
A) raise reserve requirements in 1936-1937.
B) lower reserve requirements in 1936-1937.
C) raise the monetary base in 1936-1937.
D) lower the monetary base in 1936-1937.
Answer: A
7) During World War II, whenever interest rates would ________ and the price of bonds would
begin to ________, the Fed would make open market purchases.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
Answer: B
8) During World War II, whenever interest rates would rise and the price of bonds would begin to
fall, the Fed would
A) lower reserve requirements.
B) raise reserve requirements.
C) make open market purchases of government securities.
D) make open market sales of government securities.
Answer: C
9) During World War II, the Fed in effect relinquished its control of monetary policy through its
policy of
A) continually lowering reserve requirements.
B) continually raising reserve requirements.
C) pegging interest rates.
D) targeting free reserves.
Answer: C
10) The Fed was committed to keeping interest rates low to assist Treasury financing of budget
deficits
A) only during World War I.
B) during the Great Depression.
C) during World War I and World War II.
D) throughout the entire existence of the Fed.
Answer: C
11) The Fed-Treasury Accord of March 1951 provided the Fed greater freedom to
A) let interest rates increase.
B) let unemployment increase.
C) let inflation accelerate.
D) let exchange rates increase.
Answer: A
12) During the 1950s, the Fed targeted
A) M1.
B) M2.
C) the monetary base.
D) money market conditions.
Answer: D
13) During the 1950s, Fed monetary policy targeted
A) the monetary base.
B) the exchange rate.
C) discount loans.
D) interest rates.
Answer: D
14) Targeting interest rates can be procyclical because
A) an increase in income increases interest rates, causing the Fed to buy bonds, increasing the
monetary base and money supply, leading to further increases in income.
B) an increase in interest rates increases income, causing the Fed to buy bonds, increasing the
monetary base and money supply, leading to further increases in income.
C) an increase in the monetary base increases the money supply, causing the Fed to buy
bonds, increasing the monetary base and money supply, leading to further increases in
income.
D) an increase in income increases the monetary base and money supply, causing the Fed to
buy bonds to increase interest rates and income.
Answer: A
15) High inflation can spiral out of control when
A) expected inflation increases nominal interest rates, causing the Fed to buy bonds,
increasing the money supply and further increasing inflation.
B) expected inflation decreases nominal interest rates, causing the Fed to buy bonds,
C) expected inflation increases nominal interest rates, causing the Fed to sell bonds,
D) expected inflation decreases nominal interest rates, causing the Fed to sell bonds,
Answer: A
16) In practice, the Fedʹs policy of targeting money market conditions in the 1960s proved to be
A) countercyclical, helping to stabilize the economy.
B) procyclical, destabilizing the economy.
C) procyclical, helping to stabilize the economy.
D) countercyclical, destabilizing the economy.
Answer: B

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